The 2016 UK Budget (Budget), announced on March 16, 2016, has generally been seen as good news for corporates, but is not without some stings in the tail, particularly for multinationals. Notably, it reaffirms the UK’s desire to lead the way in implementing the recommendations from the Base Erosion and Profit Shifting (BEPS) action plan prepared by the Organisation for Economic Co-operation and Development (OECD), and in some respects to go beyond what the OECD has recommended.
The main headline-grabber is a further reduction in the rate of corporation tax to 17 percent from April 2020, which takes the rate significantly lower than many of the United Kingdom’s international competitors. This demonstrates the government’s desire to use a low corporate tax rate as a calling card to attract businesses (and taxable profits) to the United Kingdom. Clearly it will be welcomed by businesses already in the United Kingdom, and may attract others to locate more functions in the United Kingdom: though multinationals located in higher-taxed countries may need to consider whether the UK rate has now dropped so low that their UK subsidiaries are at risk of being caught by controlled foreign company (CFC) rules that were aimed primarily at tax haven subsidiaries.
The government also confirmed its intention to introduce comprehensive rules to eliminate hybrid mismatches with effect from January 1, 2017, in line with the proposals in the BEPS Action 2 report. In particular, these should remove the benefits from check-the-box planning frequently used by US-based multinationals and from typical Luxembourg fund structuring using hybrid instruments. The government has also announced that the rules will be extended to cover arrangements involving permanent establishments which give rise to a mismatch. This will counteract the benefits from structures whereby payments are made from a permanent establishment to the territory of residence which give rise to a deduction in the territory of the permanent establishment but are not taxed in the territory of residence. It will also counteract “finance branch” structuring of the type undertaken by many multinationals in recent years. All hybrid structures should be reviewed as a matter of urgency.
The hybrid rules will be followed swiftly in April 2017 by a restriction on interest deductibility in line with the BEPS Action 4 proposal. This will cap interest deductibility at 30 percent of a group’s earnings before interest, tax, depreciation and amortization (EBITDA), subject to a de minimis threshold of £2m and a group ratio override rule for more highly indebted groups, allowing proportionate UK deductions by reference to the net interest to EBITDA ratio of the worldwide group. While a significant change to a regime that has historically been relatively generous in terms of interest deductibility, this proposal is not dissimilar (and no less generous) to similar restrictions introduced in other major European countries in recent years, and in the context of intra-group lending, may not restrict deductibility much more than existing thin capitalization rules.
In a change that comes sooner than many had expected, the government announced that it would adopt the revised OECD transfer pricing guidance set out in the BEPS Actions 8-10 report with effect from April 1, 2016. This opens up potential discrepancies in the way that the UK and US governments apply the arm’s length standard, particularly in relation to cost-sharing arrangements: US multinationals should tread carefully. As expected, the UK is also moving to align the patent box regime with the modified nexus approach propounded in BEPS Action 5, with these changes applying to new entrants to the regime on or after June 1, 2016, and to existing claimants from June 1, 2021.
A final BEPS-related measure (though not one specifically recommended by a BEPS report) is a change to the withholding tax regime on royalties. A new provision will deny treaty relief to structures put in place for the main purpose of obtaining the benefit of the relevant treaty.
The government has, however, signaled that it does not intend to make any changes to the UK’s CFC rules as a result of the BEPS Action 3 report, and presumably will resist European Commission proposals to implement common CFC rules across the European Union. It has also promised a review of the substantial shareholding exemption, which exempts most disposals by UK companies of interests in trading companies from UK tax—something that hopefully will reduce some of the uncertainties that occasionally crop up regarding its application.
On the purely domestic front, the government also announced proposals to remove many of the complex restrictions on loss carry-forwards from April 2017, and in particular to allow losses to be relieved against future profits of other group companies (currently, group relief is only available on a current year basis). This should reduce the phenomenon of “stranded” losses with no practical possibility of being used. The quid pro quo for this reform is that relief for carried forward losses will be restricted to 50 percent of taxable profits in excess of £5m.
In short, while this is a Budget with positive aspects for corporates, the benefits mainly go to smaller and domestic businesses. Many multinationals and private equity groups will need to re-evaluate longstanding financing structures, albeit the UK corporate tax environment generally remains positive.